President, John Burns Real Estate Consulting
On Friday, October 18, The Norris Group proudly presents its 6th annual black tie event I Survived Real Estate. An incredible line-up of industry experts joins Bruce Norris to discuss perplexing industry trends, head-scratching legislation, and opportunities emerging for real estate professionals. Proceeds for the event benefit Make a Wish and St. Jude’s Children’s Research Hospital. This event would not be possible without the generous help of the following platinum partners: PropertyRadar and Sean O’Toole, HousingWire, the Apartment Owners Association, the San Diego Creative Real Estate Investors Association and President Bill Tan, Investors Workshops, InvestClub for Women and Iris Veneracion and Bobi Alexander, San Jose Real Estate Investors Association and Geraldine Barry, MVT Productions, Wilson Investment Properties, RODA Construction , and White House Catering. For event information and tickets, visit www.isurvivedrealestate.com.
Bruce Norris is joined this week by John Burns. John is the CEO of John Burns Real Estate Consulting. John and his team consult with executives all over the country analyzing and summarizing the information they need to make housing industry decisions with more confidence. The company is on retainer with many of the largest companies in housing and investment industries. They produce regular monthly reports on housing market conditions and customizing specific studies to help with strategic and community-specific decisions. John is also a frequent speaker and has been interviewed by most of the major media.
Bruce and John first met back in 2005, so he was curious about how John’s client base has changed from 2005-2013. John said it has changed several times along the way, and now it is starting to come back to the “same old, same old” and back to homebuilders again. In the meantime, they have spent a lot of time with the distressed investor and bank workout crowd. They are also still working for the single-family rental people, which was not even a term with which he was familiar in 2005. What is interesting about this is that each piece of the industry that he was forced to touch probably expanded how much he knew. What he loves most about his job is talking to people who touch this industry in many different ways, seeing what they are seeing, then trying to pull it together for everybody.
Bruce also asked about staff growth from where he was in 2005 to now in 2013. John said they have expanded and are at about 42 people now, which was about half this size back in 2005. This is a pretty major accomplishment for the industry that he was specifically in for to have gone on vacation for a time to have grown the business and actually come out stronger. John said they are in demand when a lot of people need help figuring out the business and there is money to be made. Obviously there was money to be made during both the downturn and the upturn. John’s business does not do well when housing is boring, and it has been a while since his has happened. Boring has not been a part of the landscape, that is for sure.
Bruce asked John if his staff has assignments, or do they get a chance to free roam and make discoveries. John said 2/3 of his business is consulting business, which is specific project-oriented. This means they are out in the field kicking tires. They have an office in Atlanta now, in Chicago, and a couple in Florida and Dallas. They have been expanding, so he has gotten better color from what is going on at the ground level. 1/3 of his business is subscription research business, which are mostly located here and are pulling together all the information and anecdotes. Bruce said he gets a big kick every time he figures out just one chart a year that he did not have before and saw how meaningful it was. This was something he did not know would matter, and it matters. It is all part of a puzzle where you are trying to put it together and figure out what will help you to predict something more accurately than he is currently doing. John said they are doing one of these charts every month, or at least every other week. Right now they are doing a lot of research on the foreign buyer and trying to really understand what has been driving them. The question is if they have pulled back, and if so why?
Bruce said the only information he has really been able to look at is what CAR provided. The thought was that everything was on sale in 2008-2010, and now it is more expensive. Therefore, there is going to be a pullback. If you look at the history of the foreign buyer, it is anything but this. They usually participate more at the end of the cycles than they do in the beginning. Their human nature kicks in, just like a lot of local investors or speculators. Their participation generally gets more aggressive in an ’05 than it does in a 2000. It will be interesting to see what John comes up with this time.
John said this time around, it has been different. They have seen a tremendous surge in foreign buyers in the last two years. He has even heard that in California they have pulled out in the last couple months, particularly some of the Chinese buyers. From the work they are doing in Florida, it looks like they are now in this state. This group is different from the somewhat wealthy individuals. They are more professional individuals. Given where the exchange rate is and how much housing is beat up as well as what is going on in the local market, John said he would like to own some real estate in the U.S. as part of his long-term investment strategy. It will be interesting to see if their place is taken by the more speculative person. John said this is his bet. He has had several phone calls from hard money lenders who are trying to raise more money and want them to do market overview for their offering. He is generally telling them no, which means debt is becoming more available. He is seeing more ads on television for people to come to his seminar to learn how to flip a house for $30,000 in profit. To him, these are warning signs.
Bruce asked if the warning signs are that things are heating up, or that real estate is getting back to how it was. John said what he means is people believe real estate is where you make a quick buck. You find flippers who sell to other flippers, and at the end of the day someone gets left holding the bag. Bruce agreed that it does change the participation type as well as the sophistication of the participant. This is where the music ends, and there can be somebody holding the bag. If you were holding it in 1991, that was not as painful as it was in 2007. John said flipping homes is a reasonable thing to consider doing right now and not something we should go to jail for or anything. You are doing it because you are buying for lower replacement cost or you see that it is more beat up than usual. The question is when the affordability industry will see the road and when some of the other things they track flash warning signals. This is when you exit. Bruce said as far as what he looks at, we are close to that day at least in California in general. You could go up to San Francisco and cherry pick areas where you see that it almost is over 2006 and 2007 numbers.
Bruce said what is interesting about all this is that it proves that people are who they always are. People in the U.S. always want to make a quick buck. Bruce actually just spoke in San Jose, and the same group who probably got burned in 2007 from prices receding probably realized the 2006 prices were probably on the ridiculous side. This same group is now past that number and feels it is completely justifiable. Earnings have also not changed very much, so you would wonder why this would be a different outcome. Just because it has not happened yet, you are making it a reasonable thing when it may not be.
Real estate prices have certainly taken off, and Bruce wondered how this has affected the building industry both nationally and in California. John said all the public home builders have completely made it through the cycle. They have gone to the debt markets and raised a lot of money at very low interest rates. This money in turn does not have to be repaid for many years from now. This has allowed them to get very aggressive and to pick the number in your area for how much home prices are up in the last year. You can then multiply this by 2-3 and say that this is how much land prices have increased. Home prices are up 15, and land prices are up by 45. The biggest impact has been that anybody who had land to sell is making a fortune. Not so much in Southern California, but in other markets they have seen land at peak pricing. This is creating a challenge for the homebuilder who needs land. We may be in the second or third inning of the recovery, but the price you have to pay for the land is in the 7th or 8th inning. This is a tough business decision to make.
Bruce said the reason it is such a tough business decision is because usually you do not get to profitably build on this until the late innings. Right now the profit margins on these land deals are so narrow that it is almost 0 if no home price appreciation occurs. People are putting appreciation before performance to make it make sense. Bruce said they were thinking of being a builder, and they built a home as a spec to put the pieces of the puzzle together to get everything they need to in order to be a builder. They looked at the numbers and at the competition, and they realized they were not going to be the best in the world at it and were going to leave it to others. However, you do wonder how some make a profit with the prices per square foot. John said you can look at the financials the public is reporting, and you see that the profits are pretty minuscule.
Bruce asked when we are seeing some increase in building, are they predominately building on lots they have owned previously or lots they are creating from scratch. John said it is mostly lots in good locations, so he would say it is some of both. The preference is to buy a ready-to-build-on lot in a good location. The second preference would be to develop the lots and then build on it. The demand to go out to the outlying areas is not nearly as strong, even though you can build a really good case that it is much less risky to go to a C or D market right now than an A or B market. The builders just want to stick to the As and Bs because they know that is where people want to live. If they have a downturn they may lose money, but at least they will know they can sell a house. Bruce asked if this was a philosophy change, to which John said he thinks it is a temporary philosophy change. It is a reaction to the downturn, although they will be buying in the C and D locations soon enough.
Bruce was confused because he looks at the sub-division creation in Riverside and San Bernardino, and it is down still by 95%. Bruce asked if this is somebody saying it is not worth taking a risk. This is where you would have to put in the extra sub-divisions since you cannot put a lot of them in Orange County. John thinks they will pay a premium to be in the dairy lands or in Corona, but you cannot give away the land in Hemet right now. This is the dynamic with which we are dealing right now.
As far as unsold homes as a percentage of inventory, Bruce wondered if it has even been lower. John said it was lower a couple months ago, and he has seen inventory levels creep up in the last 3-4 months. However, they have still been very low by historical standards. Bruce asked if the market has changed enough that it looks like it will be a new direction change and not just a little bit of a glitch. John said how he would summarize it is his very bullish tone has gotten a lot more conservative. However, he still has a positive outlook on the market. We probably completed about three years of price recovery in one year. Bruce said a lot of it is really the math. If you take a look at normal recoveries like in 1997 when we had anything positive or 2000, you see how unusual things are.
Bruce said he is always bombarding his own information with questions. When you have 2 ½ months of inventory, you start asking questions such as if you have ever had prices accelerate. When you do have a large acceleration of inventory, including the spikes from 4 months to 12 months, Bruce wondered if this is due to inventory increase or lack of sales. Usually it is a lack of sales, and you can come back and say ok. Bruce asked what the makeup of our demand is; and if that makeup is geared toward a hedge fund or investor whether there is a pile of occupant buyers ready to take their place. John said it varies by market. We have an all-time high level of investment activity right now as a percentage of sales higher than in 2005. This includes Wall Street, the local people, the foreign buyers, and second home buyers. What is missing is we have a much lower than usual percentage of first-time buyers. This is really surprising given that so many people are still trapped in their house under water. You would think the first-time buyer would be out a normally large percentage, and instead we have the opposite.
Bruce asked if it is possible that they wanted in, but they have literally been up against 100 cash offers while they are trying to get an FHA loan. John thinks the most qualified people have gotten in one way or another. His view of it is that the entry-level buyer is just not as qualified from a FICO standpoint as they were even six months ago. The story about being out bid by cash buyers is very true; and this has helped the home builders since you can always buy a new home, you just have to wait for them to finish it. A lot of those folks were driven to the new home market. He said they were less qualified than they were a few months ago. Bruce wondered if this was because they had credit damage or if the lenders had tightened things up even more. John said the most qualified people who are waiting out the downturn have gotten in, so the people left have credit issues.
However, the criteria for getting a loan certainly has changed. FHA even had a category for under 500-430 as a percentage of their loans. Now, 9% of their mortgages are going to people under 630. That world has changed to almost look like a Fannie Mae loan. This has been voluntary on the bank’s part because they have common sense and know that somebody with a spotty track record is more likely to go into foreclosure than somebody with a pristine track record. They know that even if FHA or Fannie and Freddie are insuring or buying it, if that loan goes into default it will be put back on them. Bruce said the overlays are a big issue, although John said if they were a big issue then it would sound to him like the banks were stupid.
John said he would not be lending a 95% loan to somebody who has a track record of not paying their bills, and Bruce would not either. Bruce said what is interesting is that if he were in there position, he said he actually would do this if he could look at it and say if you do this the demand increases to where you are going to have a price movement to where that 5% equity margin changes very quickly to a 25. This would be where he would have some flexibility on when it would be okay and when it would not be okay. John said even though this makes sense, there is an interest rate associated with it also. John said at 4 ½%, he is not making that loan. If that guy gets laid off, two weeks later he will not be able to pay his mortgage. Bruce wondered why they do not just make it a subject to, like assumable without qualifying to some investor. They might take it, but they would probably want a higher interest rate.
Bruce said what is fun about the upcoming I Survived Real Estate panel is that they will be able to discuss some of the aforementioned. Bruce said we have the numbers to where we should have pent up demand from occupants. However, we also have policies that will not be able to lend them the money safely, so Bruce wondered if California will stay where it is at 430,000 sales. We probably could go to 600,000 sales. John thinks there is an element of this recovery that he is starting to pay more attention. He looks at the job growth, which you can see a fair amount of in professional business services and financial activity.
He saw that a majority of these jobs were driven down, and more than 50% of these are temp jobs. These are not the type that will give people the confidence that they can go to get a 30-year mortgage. John said you throw this in on top of student loan and credit card debt, and they are not even showing up in the sales office. They are just saying they do not want to take on a thirty-year mortgage. This is disappointing to him because he thinks they have already missed a buying opportunity of their generation, and it will only get worse. It is interesting when you can come up with a major magazine with a cover in around 2010 that says something about challenging the idea of owning a home. He remembers looking at the cover and it reading, “Is it economically feasible?” Bruce thought getting to fix a payment at 3 ½% interest at the price currently available is very economically feasible, and if it wasn’t he would not know what else is.
Bruce asked about FHA. There are a couple policies they just changed. One of the new policies is that after one year, you can get a loan after a BK foreclosure or short sale. He also heard an announcement on the radio that they were talking about lowering the FHA loan limit. This is something Bruce thinks would be damaging. John agreed that both policies are occurring. At first he thought that the one-year change would get a lot of boomerang buyers, which is the term for people who went through foreclosure. They are homeowners with two kids and a dog, and they want to own again. What he has learned is that one year is really not enough to clean up your credit, which is pretty trashed after one year.
It is much harder to get a loan just because of your credit. The lower limit will be a bigger deal, and it will be a particularly bigger deal in California. It will mostly impact the marginal credit person. Even if FHA had a 670 FICO, which is the bottom third of the country, you can still get a loan that is FHA insured all day long. It now has to be Fannie and Freddie or a jumbo mortgage since Fannie and Freddie limits are supposedly coming down as well. With a 670 FICO, you may not even get a loan.
Bruce asked what the limits are coming down to now. John said they are speculating. He talked to the Wall Street Journal reporter, who is going to cover it and he did not even know. Bruce has a pretty good idea of the history of it. If they go back to the former forumula, it is only about half of Fannie’s numbers. 417 was the number John remembered, and this was a Fannie Mae number. FHA had a number of 360. In Riverside when we had a 350 median price, Bruce remembered going back to see what the FHA loan was for Riverside at that point. At that point Riverside’s FHA loan was 500 when before it was 170. At that time it was way less than the median price, but now it has spiked quite a bit.
John Burns will be featured this year on the panel at I Survived Real Estate 2013. The Norris Group would like to thank its gold sponsors for supporting I Survived Real Estate 2013: Adrenaline Athletics, California Property Solvers, Coldwell Banker Town and Country, Claudia Buys Houses, Elite Auctions, FIBI (For Investors By Investors), In a Day Development, Inland Empire Investors Forum, Inland Valley Association of Realtors, Investor Experts Inc, Keystone CPA, Las Brisas Escrow, Leivas Associates, Mike Cantu, Northern California Real Estate Investors Association, Northern San Diego Real Estate Investors Association, Orange County Real Estate Investors Association, Orange County Investment Club FIBI, Personal Real Estate Magazine, Pilot Limo, Primary Residential Mortgage, Realty 411 Magazine, Rick and LeaAnne Rossiter, Southwest Riverside County Association of Realtors, Sonoca Corporation, Spinnaker Loans, uDirect IRA, Tony Alvarez, and Westin South Coast Plaza.
See www.isurvivedrealestate.com for more on the event and all of our sponsors.
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